‘Committing Economic Suicide’

If you read nothing else on this blog, read the following KEY IMF REPORT FINDINGS bullet points for the truth into this recession.  It blows the lid on Brown and Darling’s falsehoods.

The IMF has just published its latest report into the health of the UK economy.  It tells a lot more than what Chancellor Darling & PM Brown would want to.  For those that are happy to read the whole massive report, take a look here.  http://tiny.cc/O5fsu

In a nutshell, I have pulled out some of the key paragraphs for your review.  Before we come to them, for the quicker blog readers, this is what we learn…in a few bullets:

IMF KEY FINDINGS

-           A key phrase in this document for me is this:  ‘Imbalances and balance sheet strains had emerged even before the recent global shocks triggered a sharp decline in economic activity’.  ie we were heading into recession BEFORE the Global shocks took place.

-           Household indebtedness will constrain the pace of recovery.  In the run-up to the crisis household debt increased to 175 percent of disposable income—one of the highest levels among advanced countries

-           GDP will fall by around 4.5% this year

-           Public debt projected to double in 5 years

-           Our Financial system may not yet be repaired so that banks are ready to lend again!

-           WE HAVE TO CUT SPENDING.  ‘Implementing an ambitious fiscal consolidation plan will be essential. The focus should be on putting public debt on a firmly downward path faster than envisaged in the 2009 Budget’

-           House prices have dropped by more than 20 percent from their peak and commercial real estate prices are down by 40 percent.

-           Little consumer confidence due to constrained credit and unemployment.  This limiting recovery           

-           The monthly growth of both secured and unsecured household credit has fallen almost to zero.

-           The cut in VAT rate has failed in its aim, (coupled with the larger personal allowances). ‘Nonetheless, the size of the discretionary stimulus and its impact on debt levels is small’

-           Government debt was already too high pre the recession.  ‘The structural fiscal position was already weak at the onset of the crisis—government expenditure as a share of GDP has increased substantially in the last decade, while some of the revenue strength financing the increase has proved to be unsustainable’

-           The IMF cannot make any judgement on the effects of Quantative easing.  Is it working?  Has it had any effect?  Who knows?  The IMF don’t!

-           Sure you would love to know the cost of the bailouts - broken down. Total: £904bn or 63% of GDP. A few highlights:

Northern Rock — £14.6bn.
Bradford & Bingley — £24bn
Kaupthing Singer & Friedlaender — £3.3bn
Landsbanki — £4.5bn
Heritable — £500m
Dunfermline — £1.6bn
All bank recapitalisation — £78.1bn
Credit Guarantee Scheme — £250bn
Working Capital Scheme — £11.5bn
Asset-Backed Securities Guarantee Scheme — £50bn
Asset Protection Scheme — £466bn

TOTAL TAXPAYER EXPOSURE: £904bn or 63% of GDP.

IMF Key Paragraphs in more depth

Looking ahead, the economic recovery is expected to be subdued and gradual as banks and households go through a difficult balance sheet adjustment. With the economic downturn heightening the risk of further large credit losses, banks have tightened the supply of credit. The high level of household indebtedness is also likely to constrain the pace of economic recovery. GDP is projected to fall by about 4¼ percent this year, with quarterly growth picking up gradually through 2010. The speed and strength of the recovery, however, remain highly uncertain, given the unprecedented nature of the crisis and the importance of confidence effects.

Notwithstanding recent signs of stabilization, underlying vulnerabilities in the UK are sizeable.The financial crisis has brought about a dramatic deterioration in public finances. Public debt, although starting from a relatively low level, is projected to double in five years. The sharp increase in government borrowing and contingent liabilities, together with continued financial sector fragility, are significant vulnerabilities. In these circumstances, a severe shock has the potential to disrupt domestic and external stability. This highlights the importance of credible and consistent policies to truncate downside risks and strengthen market confidence. The main policy priorities remain, first, resolving the problems in the financial sector to buttress stability and promote normalization of credit supply, and second, setting monetary and fiscal policies consistent with a firm commitment to the existing policy anchors of price stability and fiscal sustainability.

 Repairing the financial system is essential for achieving a sustained recovery. The authorities’ policy interventions have averted a systemic breakdown in the financial sector. But the financial system may not yet be repaired to level where banks are ready to increase lending sufficiently to underpin a strong recovery. Although major banks are expected to remain above minimum regulatory capital requirements, recession-related credit losses will lead to an erosion of capital buffers. At the same time, it is doubtful that increased capital market funding can compensate for shortfalls in bank lending. It will therefore be important for the authorities to continue to:

• • Seek further strengthening of banks’ capital positions by encouraging banks to take advantage of improving market conditions to augment their capital base and, if necessary, providing further public capital support.
• • Promote options to preserve capital cushions and improve capital structures, for example by restraining dividend payouts not supported by profits and converting preference shares to common shares.
• • Develop contingency plans in the event that further shocks threaten the stability of financial institutions.
• • Support credit supply through targeted and appropriately designed intervention in dysfunctional credit markets.

More fundamentally, the success of the current policy package hinges on continued trust in the sustainability of the fiscal position. A strong commitment to reverse the sharp deterioration of public finances within a reasonable timeframe is crucial. Therefore, once the economic recovery is established, implementing an ambitious fiscal consolidation plan will be essential. The focus should be on putting public debt on a firmly downward path faster than envisaged in the 2009 Budget. The credibility of such plans would be enhanced by clarifying early the specific measures needed to achieve the adjustment, including in the context of the next Comprehensive Spending Review. The emphasis in current plans to weigh the adjustment toward expenditure reduction is appropriate in light of international experience that expenditure-based consolidations are more durable. Long-term sustainability would also be helped by implementing structural reforms to address the rising costs associated with demographic change. Building a broad public consensus on the need for sizeable fiscal adjustment will be essential in meeting fiscal challenges.

Imbalances and balance sheet strains had emerged even before the recent global shocks triggered a sharp decline in economic activity. These included overheating in property markets, low domestic saving rates, high current account deficits, large external liabilities, rising (albeit still low) public debt, and significant increases in the leverage of financial sector and household balance sheets.

Household balance sheets are also highly leveraged.  In the run-up to the crisis household debt increased to 175 percent of disposable income—one of the highest levels among advanced countries . The rise in debt was matched by an increase in the value of housing, pension funds, and other financial assets held by households. However, the sharp fall of asset prices since the beginning of the crisis has eroded the value of household portfolios. Net household wealth in the UK is estimated to have declined by about 15 percent in 2008, and may fall further in 2009.

House prices have dropped by more than 20 percent from their peak and commercial real estate prices are down by 40 percent.  So far, prices have been falling much faster than in the previous major real estate price correction during the early 1990s.  Mortgage arrears and bank repossessions of properties have increased, although they are still relatively low as a share of existing mortgages. The foreclosure rate in 2008 was only 0.35 percent, compared to 4¼ percent in the United States. Delinquency rates on non-conforming mortgage-backed securities of the newer vintages are going up, but are still not far above the rates on older vintages (and are much lower than the delinquency rates on US subprime mortgages). Despite some recent positive news, forward-looking indicators such as mortgage approvals and the sales-to-stock ratio suggest that the housing price adjustment is yet to be completed.

Consumer spending has weakened on falling wealth, rising unemployment, and tighter credit constraints.   Employment is declining, and the unemployment rate reached 7.2 percent in the three months to April 2009. The rise in uncertainty about future income and employment prospects and the fall in household wealth are weighing on consumer confidence. Simultaneously, credit constraints have become more binding: recent credit conditions surveys show significant tightening of credit standards for both secured and unsecured household lending. As a result, the household saving rate has been rising—from very low levels— since early 2008.

Firms entered the crisis with relatively strong balance sheets, but vulnerabilities are increasing.  The rise in non-financial corporate debt over the last decade has been moderate, and firms have held substantial liquid financial assets. However, the profit outlook has deteriorated as demand continues to contract and credit conditions remain tight. Business investment has declined steadily over the last year, and surveys suggest that both demand for and supply of credit to corporations have contracted. Default rates have started to rise, although from a low base. The steep fall in commercial property prices has reduced further the net worth of corporations.  

Over the past year, adverse feedback loops developed between deteriorating financial conditions and a weakening economy.  Banks, constrained by tight capital positions and a difficult funding environment, reduced lending to the private sector. As house prices kept falling, the value of pensions and other financial assets declined, and job security became elusive, consumers retrenched their spending. The decline in consumption, in turn, reduced business profits and depressed investment, leading to further falls in employment and income. Demand for credit also weakened as households and businesses tried to repair their balance sheets. The actual and prospective rise in defaults and bankruptcies has weakened further the balance sheets of banks and their ability and willingness to restart lending.  

As a result, credit flows have stagnated and lending rate spreads remain high.  The monthly growth of both secured and unsecured household credit has fallen almost to zero. A pick up in the issuance of bonds by the corporate sector in recent months has not been sufficient to offset the net decline in business credit from banks. Indeed, the reduction in credit growth is steeper than in previous recessions. At the same time, lending spreads remain wide, reflecting a perception of high credit risks and increased capital costs. Corporate bond spreads over government bonds also remain elevated.   

The financial crisis and the recession have led to a sharp deterioration of public finances.  Revenue in the UK is sensitive not only to the economic cycle, but also to asset prices and the level of financial sector activity. The synchronized downturn of the economic and asset price cycles led to a rapid decline in income and corporation taxes, VAT, and asset price-related revenues. The headline deficit in 2008/09 was 6½ percent of GDP and deficits of about 13 percent of GDP are projected for 2009 and 2010. Discretionary fiscal stimulus of 2 percent of GDP is being implemented. The main components of the stimulus package are a temporary reduction of the VAT rate, larger personal income tax allowances and pension transfers, and advancing of planned capital expenditure. Nonetheless, the size of the discretionary stimulus and its impact on debt levels is small compared with the effect of automatic stabilizers and the loss of asset pricerelated revenue.  

Public debt is rising fast.   The structural fiscal position was already weak at the onset of the crisis—government expenditure as a share of GDP has increased substantially in the last decade, while some of the revenue strength financing the increase has proved to be unsustainable. Sizable fiscal deficits were recorded even as the cycle reached its peak. The post-crisis increase in net borrowing is projected to result in a doubling of gross general government debt over the next 5 years to about 99 percent of GDP. At the same time, contingent liabilities of the government from financial sector interventions have increased sharply. Gross resources committed to financial sector support measures so far have exceeded 60 percent of GDP, although the net cost to taxpayers is likely to be much smaller.

However, it is yet too early to judge the effectiveness of QE.  In principle, the significant liquidity injection should induce investors to rebalance their portfolios, thus lifting asset valuations, generating positive wealth effects, and facilitating new issuance. Targeted purchases of private assets can complement these effects by directly reducing excessive risk premia and reviving market activity. The initial evidence has been moderately encouraging as gilt yields have remained low since the launch of QE, despite the countervailing effect of large new government debt issuance. Meanwhile, spreads on commercial paper and corporate bonds have narrowed, amid a broader recovery of asset prices. It remains to be seen, however, whether these effects will be sufficiently strong and lasting to generate the desired rise in aggregate demand. This uncertainty strengthens the case for further diversifying the BoE’s asset purchases, especially by targeting private credit markets that are currently dysfunctional but deemed to be viable in the long run. The BoE noted that efforts in this direction were underway but that setting up appropriate facilities took time. In mid-June, it announced its intention to start buying certain types of asset-backed commercial paper.

Grim Reading……